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Time to Break up Big, Bad Apple?

One of the unusual characteristics of the computer industry in recent years is the rapid rise of companies to almost complete market dominance of their respective sectors.

Things began with Microsoft, whose Windows operating system is still unchallenged on the desktop. Then came Google, which more or less owns the online search world (with the notable exception of the important Chinese market), and after that Facebook, which is probably hurtling towards 800 million users at the moment. What this means is that it is almost impossible for other companies to enter those particular markets and compete against the incumbent.

It's not hard to see why this has happened. It's all about network effects: once a particular player becomes established in a new market, it attracts more users than anyone else, ensuring that it grows yet bigger and more dominant. This kind of stranglehold is typically only broken once a step change in technology occurs that allows the story to begin all over again (the transition from MS-DOS to Windows was one such.)

Although there are many big and successful computer companies around at the moment, one stands out. Apple is currently going from strength to strength, as its recent figures show:

Apple today announced financial results for its fiscal 2011 third quarter ended June 25, 2011. The Company posted record quarterly revenue of $28.57 billion and record quarterly net profit of $7.31 billion, or $7.79 per diluted share. These results compare to revenue of $15.70 billion and net quarterly profit of $3.25 billion, or $3.51 per diluted share, in the year-ago quarter. Gross margin was 41.7 percent compared to 39.1 percent in the year-ago quarter.

Much of that was down to Apple's success in two emerging markets:

The Company sold 20.34 million iPhones in the quarter, representing 142 percent unit growth over the year-ago quarter. Apple sold 9.25 million iPads during the quarter, a 183 percent unit increase over the year-ago quarter.

As a result of those and previous excellent figures, some expect Apple to become the largest company by market capitalisation in the world. Already, it holds an astonishing $76 billion in cash. This has inevitably led to all kinds of speculation about what Apple might do with it, with people noting that it could easily buy many leading computer companies, or the entire mobile industry:

With an estimated $70billion of cash sitting there waiting for the right moment, it means that it could buy Nokia, RIM, HTC, Motorola and Sony Ericsson and have change to spare.

The only company that Apple couldn't afford to add if it went on a spending spree would be Samsung, valued at $53b, although the Cupertino based company could buy them if they weren't fussed about the others.

Actually, given the company's current valuation of over $350 billion, it could easily borrow enough to buy Samsung too.

Of course, doing that would certainly be viewed askance by anti-trust authorities around the world, so it's not something it would even contemplate. What it is actually doing with the money is far more subtle, but potentially just as insidious.

For example, Apple paid $2.6 billion of the winning $4.5 billion bid for the Nortel patents. That on its own wouldn't cause any concerns were it not for the fact that Apple has started using patents on a massive scale against its competitors, notably in the smartphone market, and specifically against those using the Android platform (which is the open source angle in all this.)

This is not simply a matter of tit-for-tat: Apple may be on the receiving end of many (spurious) claims of patent infringement, but these lawsuits are clearly attacks, targetted against its rivals in the smartphone sector – even though some of them, like Samsung, are also its partner elsewhere.

The patent system cannot cope with modern technologies that often have hundreds of interacting subsystems (I'll be saying more on this in a later post). As a result, it is almost certain that Apple's competitors are infringing on some of its patents, if only because many of the latter are trivial and impossible to innovate around (one of the big problems with such monopolistic systems.)

Acquiring yet more patents means that Apple will be able to attack even more competitors – for example, US- rather than foreign-owned – even more aggressively, probably forcing them to license such patents at who knows what cost. Again, that's why monopolies are generally acknowledged to be very bad things: they give the monopoly holder unchecked and hence abusable power to set the terms of the deal.

What makes this worse is that it is totally unnecessary. Apple is a genuinely innovative company that produces a wide range of goods that people are happy to pay premium prices for – a sure sign of demand. There seems little doubt it could both carry on innovating and charging such premium prices without needing to adopt bullying tactics that involve exploiting the broken patent system.

This change in strategy, coupled with its immense cash reserves and stratospheric valuation, makes Apple a real problem. Using its patent portfolio to attack competitors does not promote innovation – on the contrary: it discourages smaller companies with exciting new ideas from even entering the markets where Apple is so powerful, since the risk of being sued for alleged infringement is now so great.

So how can we retain Apple's innovation – and thus keep customers happy – without allowing it to abuse its immense power to stifle competition? The obvious solution is to abolish software patents altogether; sadly, there are no indications that is going to happen in the US, say, in the immediate future. Given that Plan "A" probably won't work, what might we do for Plan "B". Well, how about breaking the company up in the following way?

Alongside separate companies for each main business line – computers, smartphones, tablets and entertainment products, a separate company holding all the patents and copyrights could be created. This would be obliged to license its holdings to all on a FRAND basis, ensuring that a level playing-field were created. By decoupling the patents from the products, there would be no incentive to attack small, innovative companies that might one day threaten the latter, since it would be a waste of money for no direct benefit.

Similarly, allowing others to license Apple's software would allow a market to be created in systems running that software. That would introduced greater choice and competitivity to the computer, smartphone, tablet and music sectors, to the benefit of consumers. Indeed, it could be argued that such a move would help Apple counter Android's main advantages far better than simply using the blunt instrument of patents, since it addresses the root cause rather than whacking the symptom – a huge and expanding ecosystem of independent companies basing amazingly varied products on Android.

As to the justification for such a move, it would be essentially the same as the one the judge used at the conclusion of the anti-trust trial against Microsoft, when he proposed breaking up Microsoft in a similar way – a move that many independent observers at the time thought might be quite a good idea, despite the cries of horror from Microsoft. That is, that consumers and investors would ultimately be better served by such an arrangement.

After all, the fact that Apple is hugely successful, with enormous cash reserves, is not, in itself a justification for its approach to business. If its current obsession with suing rivals rather than simply competing with them directly continues, it could have a chilling effect on the technological landscape in the US (and beyond, but I don't expect the US authorities to worry too much about that.)

At a time when the US economy is struggling, the application of this kind of massive brake to one of its most vibrant elements is surely the last thing policy makers will be wanting. Splitting up Apple may be a radical move, but desperate times require just such desperate remedies (as growing numbers of lobbyists paid for by US companies who start suffering at Apple's hands will doubtless point out.)

Moreover, this is not "punishing" Apple for its success. By definition, that success ought to have made Apple more tolerant of its rivals; instead, it seems to grow more paranoid by the day. This move is purely aimed at "punishing" the anti-competitive use of intellectual monopolies, and should equally be applied to any company that starts to "go bad" in the same way. Given the dynamics of the computing world, and the probable continuing existence of market-distorting instruments like patents, it's quite likely that Apple will not be the last company to reach such heady levels of power – or to abuse it.

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